China: No, I Was Not Disappointed by Premier Wen’s Speech

Strangely enough I think I am among the least disappointed people about Premier Wen’s speech this morning during the opening of the National People’s Congress. Like most people I think there was very little of substance in the speech except the usual statements about boosting consumption, maintaining growth, and promoting social welfare – all easier said than done – and I have already argued many times, in a recent blog entry, for example, and in today’s WSJ Op-Ed piece, that China’s development model and financial system make it very difficult for China to boost consumption in the short term except by boosting investment, which is both slow and contrary to China’s role in the global crisis.

The main thing I got from his speech is that while Premier Wem claims that China is ready significantly to expand its stimulus, for now policymakers plan to wait and see what are the effects of the current stimulus spending. This makes sense, I think, because there is a real risk that continued deterioration in the global environment and rising domestic unemployment may panic the government into throwing everything they can into the stimulus mix.

And if they do, what will that accomplish? Global demand is contracting so there is no way to get around the fact that Chinese overcapacity will have to decline, and since it cannot decline sufficiently via a sharp increase in net domestic consumption, it will inevitably decline in the form of reduced production, especially as the threat of protection, which Wen explicitly addressed, rises.

I think to a certain extent this was recognized by the premier. According to Xinhua’scoverage of the speech:

When delivering a government report to the annual session of the Chinese legislature, he said that the global financial crisis continues to spread and get worse. Demand continues to shrink on international markets; the trend toward global deflation is obvious; and trade protectionism is resurging.

“The external economic environment has become more serious, and uncertainties have increased significantly,” he said. “Continuous drop in economic growth rate due to the impact of the global financial crisis has become a major problem affecting the overall situation. This has resulted in excess production capacity in some industries, caused some enterprises to experience operating difficulties and exerted severe pressure on employment,” according to the Premier.

But what if policymakers try to force the problem away? The risk is that they cause a massive increase in investment in the hopes of boosting employment, but if this boost comes as a consequence of building even more capacity, there are, in my opinion, likely to be two very dangerous outcomes. First, they will enter next year with even more excess capacity, and second they will have weakened the banking system further and increased government direct and contingent indebtedness.

If the world recovers quickly, then none of this will matter. But if it doesn’t, China will face 2010 with even more excess capacity and in a much weaker fiscal position to combat the contraction.

There were a few worrying aspects to the speech. Recently there has been an increasing chorus among exporters demanding RMB depreciation, and three days ago Commerce Minister Chen Deming said that February’s trade figures would be much weaker than January’s. According to an article in the South China Morning Post:

Mr Chen did not rule out the possibility that the country would adopt some trade protection measures but said it would resist out-and-out protectionism. “Trade protection does not equal protectionism. Some measures are allowed under the [World Trade Organisation] framework,” he said.

I am not sure I understand how trade protection is different than protectionism, except perhaps in a strictly legalist sense that will hold little water in the global debate. I would propose, if anyone wanted my opinion, that the world’s leading exporter by far of overcapacity – and the only major country that has seen its trade surplus surge during the crisis – does not need to push exports, especially not via any form of protection, legal under WTO rules or not.

More worrying, at least superficially, it seems that it was not just Chen who is making these kinds of noises. The People’s Daily, in reporting today’s speech by Premier Wen, had an article with the kind of headline almost designed to catch my eye: “Wen’s report urges unslackened efforts to promote export.” According to the article:

…”We will continue to diversify our export markets and compete on quality, enhance traditional export markets, and energetically open up new markets,” said Wen. The government is to take a series of measures to relieve the difficulties of exporters and to ensure steady growth in foreign trade, according to Wen.

The rest of the article was a little less worrying, suggesting mostly anodyne feel-good measures:

A central government fund for trade development will be increased, eyeing to cultivate brand-name export products and support small and medium-sized enterprises in expanding their international markets, Wen said. To improve the country’s financial services for importing and exporting, the government will expand the coverage of export credit insurance, and encourage financial institutions to develop export credit, he said.

The government will adjust the prohibited or restricted commodity categories of processing trade, and encourage the relocation of export processing industries from the eastern to the central and western regions, Wen said.

Perhaps all of this is more designed to ward off continued attacks by a frantic export sector than to represent a real attempt to force export growth. Let’s watch the trade figures over the next few months. China has only just begun to feel the impact of sharply declining exports, and is suffering a lot less than most other Asian countries. This should change soon.

Michael Pettis is a professor at Peking University's Guanghua School of Management, where he specializes in Chinese financial markets. He has also taught, from 2002 to 2004, at Tsinghua University’s School of Economics and Management and, from 1992 to 2001, at Columbia University’s Graduate School of Business.

Pettis has worked on Wall Street in trading, capital markets, and corporate finance since 1987, when he joined the Sovereign Debt trading team at Manufacturers Hanover (now JP Morgan). Most recently, from 1996 to 2001, Pettis worked at Bear Stearns, where he was Managing Director-Principal heading the Latin American Capital Markets and the Liability Management groups.